Plant size: Capital cost relationships in the dry mill ethanol industry

doi:10.1016/j.biombioe.2005.01.001

Biomass and Bioenergy

Volume 28, Issue 6, June 2005, Pages 565-571

https://doi.org/10.1016/j.biombioe.2005.01.001 Get rights and content

Abstract

Estimates suggest that capital costs typically increase less than proportionately with plant capacity in the dry mill ethanol industry because the estimated power factor is 0.836. However, capital costs increase more rapidly for ethanol than for a typical processing enterprise, judging by the average 0.6 factor rule. Some estimates also suggest a phase of decreasing unit costs followed by a phase of increasing costs. Nonetheless dry mills could be somewhat larger than the current industry standard, unless other scarce factors limit capacity expansion. Despite the statistical significance of an average cost-size relationship, average capital cost for plant of a given size at a particular location is still highly variable due to costs associated with unique circumstances, possibly water availability, utility access and environmental compliance.

Introduction

The relation between capital costs and plant size is an important determinant of the scale of a fixed-proportions enterprise. Enterprises in many processing industries have fixed proportions production processes when a unit of a critical resource or commodity input, such as corn or petroleum, provides a constant fraction of output and requires a fixed amount of processing capacity for each unit of raw material processed.

Capital cost in a processing firm is thought to increase proportionately less than size because large containers are a dominant element of capital costs and surface area increases less rapidly that volume [1]. Considerable evidence on this point is available for the petroleum processing industry, chemical industry, and grain storage industry [2], [3]. Put another way, the evidence for these three industries suggests declining average capital costs as the scale of the enterprise increases. This simple fact likely explains the massive scale that has evolved in all three processing industries. Similar questions about the capital cost-capacity relationship in the ethanol processing industry arose during recent expansions.

Some estimates of the capital cost-plant size relationship for dry-mill ethanol processing are presented in this paper. First, we review approaches to estimation. Second, we discuss the capital cost structure in the ethanol industry and summarize the data from a recent survey. Third, we present the results of estimation. Finally, we discuss the implications for reducing capital costs. Such estimates are critical to investors, financiers and economic analysts in their assessments of the financial viability and scale of processing investment in the ethanol industry.

Section snippets

Capital costs in the ethanol industry

Some information about capital costs in the ethanol industry is now available because the results of a recent USDA Cost of Production Survey are now available [4]. The capital cost and capacity data of the firms in this survey are used for a statistical estimate of the capital cost-capacity relationship.

There are two technologies in the ethanol industry. Most existing dry mills are small, with capacities range of 5–30 million gallons per year (MGY). However, dry mills constructed during the

Estimation

The power function is the standard estimation function, an idea that emanates from early research on economies of scale for fixed proportions industries [1]. Some economists also know the inverted form of the power function as the Cobb-Douglas production function [6, p. 106–7]. Based on some early estimates for typical industries, the power function is often referred to as the ‘0.6 factor rule’, which says that a 1% expansion in processing capacity yields a smaller 0.6% increase in capital

Results

For estimation, the capital variable (K) is measured in millions of dollars and the output capacity is measured in millions of gallons. Also, The ethanol plants in this sample were constructed at different times over the last 25 years. Plant construction cost data was deflated by a cost index for process equipment plants [11]. Division by the cost index converts the capital variable to millions of real dollars in year 1988.

Three types of functions are presented below. First, the conventional

Discussion of minimum unit cost estimate

The quadratic estimate of minimum unit costs suggests a range of decreasing costs followed by increasing costs (Fig. 1). The minimum unit cost estimate, $Q_{m} = 64.67$ MGY, lies within the range of the sample. The corresponding minimum cost is $0.87/ gal in 1988 dollars. In current 2004 dollars, the minimum unit cost is $1.08/gal.

Also, the standard deviation of $Q$ _m is 9.05 MGY, which suggests that the minimum unit (capital) cost is between 55.62 and 73.72 MGY, with 65% confidence. The high and low bounds

Conclusions

The estimates of this paper found some evidence of economies of scale arising from increasing plant size. Specifically, capital costs increased less than proportionately with plant capacity. However, the estimated power factor for dry mill ethanol plants (0.836), suggests that capital costs increase more rapidly than the average for all processing plants; the 0.6 power factor rule suggests more benefits for large plants.

Also, some estimates of unit capital costs suggest a phase of decreasing

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Plant size: Capital cost relationships in the dry mill ethanol industry

Abstract

Introduction

Section snippets

Capital costs in the ethanol industry

Estimation

Results

Discussion of minimum unit cost estimate

Conclusions

Economies of scale: some statistical evidence

Quarterly Journal of Economics

Grain transport and industry structure

Plant design and economics for chemical engineers

Applied production analysis: a dual approach

Microeconomic theory: a mathematical approach

Econometric analysis